"Sneak" is my term for marketing and advertising pitches and practices that are probably within the letter of the law , but almost certainly intended to mislead.
Once again, I’ve received a marketing letter from a major bank. This one is pushing that darling of the banking industry, the home equity loan, a loan that’s absolutely wonderful….for the bank.
I didn’t even have to read the fine print to know this one was a Sneak. The less-than-honest information was on the front page, in the form of a comparison of how much money could be saved consolidating debts into a home equity loan from this bank.
The hypothetical debts listed were:
* a regular credit card with a 15.9% interest rate and a balance of $30,500
* a department store credit card with a 19.9% interest rate and a $14,000 balance
* an auto loan with an 8.69% interest rate and a $45,000 balance.
$89,500 of debt total, with, according to the bank, a total monthly payment of $1,650.04.
The letter says that if I got this home equity loan, the monthly “interest-only” payment on this hypothetical debt would be $298.33, based on an interest rate of 4%.
Wow! I’d save over $1,350 a month! Give me a pen! Let me sign this thing now! "$1,350 less! $1,350 less! Go team!"
Uh-huh. Sykes, put away your pom-poms. Let’s take a slightly closer look at this thing.
“Interest only?” Most loan payments are a combination of two things, an interest payment and a principal payment, interest being the money you pay for borrowing money, principal being the actual amount borrowed. So each time you make a "principal and interest" payment, you’re paying back some of the principal, thereby reducing the amount of money you owe. But in this example, with an interest-only payment, I'd pay nearly $300 a month…..and no matter how long I paid, still owe the same $89,500.
In other words, with an "interest-only" payment, a borrower essentially pays each month to “rent” the money.
So comparing a regular payment to an interest-only payment is not exactly kosher. (Actually, it's a classic Sneak.)
Let’s suppose that a hypothetical debtor, with credit good enough to qualify for such a loan, instead found a bank or credit union that would give him a consolidation loan for $89,500 at a fixed rate of 7%.
Based on a payback term of ten years, he’d pay $1,039.17 per month. With a slightly lower interest rate or a longer loan term, he'd pay less. The important thing is, eventually he'd pay off the loan.
But—but—but—you say—according to this letter, the interest rate on the equity loan would be only 4%! Isn’t it always better to pay a smaller interest rate? How can you beat 4%?
A reasonably good argument, except for one thing. A bit of fine print on the back of the letter informs us that this is a variable rate. As many people have discovered lately, variable rates are tricky things. A four percent rise on that 4%--an entirely possible scenario--would hike that “interest only” payment from $298.33 to $596.66…and our debtor still wouldn’t be paying off the loan.
But the Sneakiest part of this whole pitch? Mr. Debtor, already in hock for a $89,500, wouldn’t qualify for that 4% rate in the first place! According to the fine print….
(…read the fine print. Always read the fine print…)
….the rate offered only applies to loans over $100,000! So unless our debtor’s willing to take on another $10,500 worth of debt, he’s not going to get 4%.
Add this to the scenario, too... if our debtor “does not meet the repayment terms”...which means, of course, if he misses a payment or two... his interest rate could jump instantly to 18%. (Darn that fine print!)
And at 18%, even an “interest-only” payment on $100,000 would be $1,500.
Plus, nowhere in this letter does it mention exactly how one does pay off this loan. No mention of length of term, or how much each monthly payment would be if it actually included some principal as well as interest.
I guess the idea is that anyone taking out such a loan is to “rent” that $100,000 for the rest of their natural life, paying anywhere from $333.33 (4%) to $1,500 (18%) a month. Nice. Really nice.
Is this offer looking not quite so good now? Yes?
Yes!
But here’s the final kicker, the thing you should always keep first and foremost in your mind when any financial institution offers you a home equity loan….
….if you can’t make the payments, they can take your home.
If you can’ t make the payments, they can take your home.
Does that mean you should NEVER take out a home equity loan? No....but the reasons, terms and conditions should be considered very, very carefully. And....
...read the fine print!
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